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EMI case settles out of court the decision that a tenant cannot assign its lease to its guarantor still stands

In 2016 the High Court considered the validity of an assignment of a lease by a tenant to its guarantor. The antiavoidance provisions in section 25 of the Landlord and Tenant (Covenants) Act 1995 ("1995 Act") strictly limit the freedom of contract of parties to leases governed by that Act, broadly, those granted after 1995. Agreements which frustrate those provisions are void even if they are commercially justifiable.

BRIEF FACTS AND DECISION

EMI Group Limited v O&H Q1 Limited [2016] EWHC 529 (Ch)

HMV was granted a 25year lease of commercial premises in Worcester in September 1996.

EMI Group Limited ("EMI") guaranteed HMV's obligations under the lease.

This lease was a "new tenancy" under the 1995 Act.

HMV went into administration and the landlord consented to HMV assigning the lease to EMI.

The assignment of the lease to EMI was completed in December 2014. As part of the assignment, EMI agreed to take on the role of the tenant and the tenant's covenants at the same time as being released as guarantor.

The High Court was asked to look at whether EMI was bound by the tenant's covenants in the lease. The High Court ruled that EMI could not validly take an assignment of a lease from HMV on the basis that:

The whole thrust of the 1995 Act was that neither the tenant nor their guarantor can validly reassume their liabilities on permitted assignments as stipulated in section 5(2)(a) in respect of former tenants and section 24(2) in relation to former guarantors.

So, if a tenant and its guarantor are each subject to the same (or essentially the same) liabilities in relation to the tenant covenants in a lease, neither can as a result of an assignment of the lease, reassume the same (or essentially the same) liabilities.

The deal that EMI did in 2014 released EMI from its liability to perform the tenant covenants under its 1996 guarantee but at the same time, that deal made EMI liable to perform the tenant covenants as an incoming tenant. This immediate reassumption of essentially the same liability by EMI frustrated the operation of section 24(2) and so engaged the wideranging antiavoidance provisions in section 25.

The court declared that the assignment of the lease was void as this was an agreement relating to a tenancy which purported to make EMI liable under essentially the same covenants from which it had just been released.

Therefore, HMV was still the tenant of the lease and EMI was still the guarantor and had not been released from its liabilities under its guarantee.

APPEAL

The case was due to go before the Court of Appeal in May 2017 with many hoping for further clarity or even a reversal of the High Court's decision, however, the parties recently settled the matter out of court on confidential terms. Therefore the High Court's decision still stands a tenant cannot assign its lease to its guarantor.

WHAT DOES THIS MEAN IN PRACTICE

Assignment of leases from a tenant to its guarantor are often commercially justifiable and many investors and occupiers will have entered into similar deals since the 1995 Act came into force. Such assignments are therefore void and the case raises questions across portfolios about the identity of tenants.

Following the assignment of the lease to EMI, EMI granted an underlease to HMV Retail Limited. Given that the assignment to EMI is void, then the underlease to HMV Retail, as a derivative interest, was also void. If EMI had further assigned the lease then presumably that or any subsequent assignments would also be void. Therefore any interest derived from a void assignment would also be void.

Many such assignments are likely to be registered at the land registry in the name of the guarantor as the new tenant who would be the legal owner with the tenant remaining as the beneficial owner.

The decision hampers inter-group assignments, and, corporate occupiers who have carried out reorganisations in the belief that they have divested companies liabilities may have to reassess their position.

There may be stand-alone guarantees which are not disclosed on the basis that they are no longer relevant and the original tenant may have assigned the lease to such a guarantor in the past. It may not be possible to see that the lease assignment is in fact void and, therefore, when carrying out due diligence it may be that more detailed enquiries are raised.

OPTIONS

The legal position in relation to assignments such as that in the EMI case remains uncertain. Parties looking to rectify the position may explore certain options including:

If all parties are agreeable, then the original lease could be surrendered with a new lease granted direct to the guarantor on similar terms to the existing lease. The landlord may however be putting itself in a worse position given that it would no longer have a guarantor and may, therefore wish to insist on a new guarantor. The `new tenant' would also need to consider SDLT implications in respect of the new lease.

Given the potential cost implications where SDLT is applicable in proceeding with the above approach, the original tenant may wish to assign the lease to an intermediate group company and then proceed with a further assignment from the intermediate group company to the original guarantor.

There are likely to be cases where the original tenant has gone into liquidation and in such cases the landlord may wish to call upon the guarantor to take a new lease in accordance with the terms of the lease however the landlord may be barred from doing so depending on the time limits in the lease for calling upon a guarantor to take new lease.

It is likely that parties may adopt the `do nothing' approach unless the issue raises its head and warrants some form of action. The landlord will of course be receiving (and accepting) rent from the guarantor and could argue that the guarantor is paying the rent as agent on behalf of the tenant.

REFORM

It is clear that reform is needed. The Property Litigation Association ("PLA") and other bodies such as the British Retail Consortium and the British Property Federation have been lobbying in respect of getting reform of the 1995 Act on to the political agenda. Proposals put forward by the PLA include the ability for a tenant to assign to its guarantor and the ability for a guarantor to stand as guarantee for an assignee provided that the tenant, guarantor and assignee are all group companies. The Law Commission called for evidence and submissions last summer and they are aiming to publish their report and draft Bill in spring 2018.

It is important to remember the preamble to the 1995 Act being "..to make provision for persons bound by covenants of a tenancy to be released from such covenants on the assignment of the tenancy..."

Therefore, a change in the position is only likely to come about if there is a change in the law following the publication of the draft Bill, or, if in the meantime the EMI decision is tested in the courts. For now though we are stuck with the decision.

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